Yellen Dip Bought, Bulls Buoyed By Fed’s Focus On Labor Market

From Tuesday’s low to Friday’s new high, the S&P 500 rallied 2.7 percent – not the kind of outcome these traders were probably anticipating. They likely covered, and this may have in fact helped the index post a new high last Friday.

Stocks’ knee-jerk reaction on Tuesday apart, they are keenly watching the short end of the treasury yield curve. The long end is on the move – albeit slightly – with the 10-year (1.58 percent) having broken out of one percent early this year and then ticked 1.77 percent on March 30 (SPTL).

But two-year yields are well anchored in a range of 15 to 16 basis points. On Tuesday, the day Yellen spoke, yields were unchanged at 0.16 percent. This section of the curve tends to be the most sensitive to interest rate policy. Historically, they have tended to lead Fed action (Chart 3).

As things stand, of its dual mandate of maximum employment and price stability, the Fed is focused more on the labor market and less on inflation.

Inflation is showing subtle signs of building. In the 12 months to last May, the consumer price index barely grew, up 0.12 percent. Post-pandemic, as the economy gradually began to open up, consumer prices began to firm up. In March, they grew at a 2.62 percent rate. Numbers for April are due out this Wednesday.

If the New York Fed’s Empire State Manufacturing Current Prices Paid sub-index is any indication, consumer prices have a lot of catching up to do (Chart 4). In April, the index jumped 10.3 points month-over-month to 74.7. Last May, it languished at 4.1.

The debate is not about if inflation is percolating, rather if the expected increase is transitory or persistent. Yellen seems to be suggesting it is the latter, although speaking at a different event later that day she tried to walk back her comments, saying any price increases would be transitory.

This is precisely the line used by the Fed. At the end of the March FOMC meeting, members raised their real GDP growth forecast this year to 6.5 percent, up from 4.2 percent made last December; core PCE inflation forecast went from 1.8 percent to 2.2 percent but is expected to moderate next year. In March, this measure of inflation jumped 1.83 percent year-over-year; in April last year, growth went sub-one percent at 0.93 percent.

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